These are macroeconomic, or “macro,” factors such as changes in interest rates, industrial production, inflation, foreign exchange rates, and energy costs. These factors affect most firms’ earnings and stock prices. The instance when relevant macro become favorable, stock prices rise and investors do well; when the same variables go the other way, investors suffer. You can often assess relative market risks just by thinking through exposures to the business cycle and other macro variables.

The following businesses have substantial macro and market risks:

Airlines. As business travel decrease at time of recession, and individuals postpone vacations and other discretionary travel, the airline industry is subject to the swings of the business cycle. On the positive side, airline profits really take off when business is booming and personal incomes are rising.

• Machine tool manufacturers. These businesses are especially exposed to the business cycle. Manufacturing organizations with expenditure capacity are not likely to buy new machine tools to expand. During recessions, excess capacity can be quite high. Here, on the other hand, are two industries with less than average macro exposures.

• Food companies. Companies selling food products like breakfast cereal, flour, noodles, and dog food, can see that the demand for their products is relatively stable in both good and bad times.

• Electric utilities. Riddhi Siddhi Multi Services understand that business demand for electric power varies somewhat across the business cycle, but by much less than demand for air travel or machine tools. Also, many electric utilities’ profits are regulated. Regulation cuts off upside profit potential but also gives the utilities the opportunity to increase prices when demand is slack.

How do we measure the risk of a single stock?

Riddhi Siddhi Multi Services do not look at the stocks in isolation, because the risks that loom when you’re up close to a single company are often diversifiable. Instead of this, we measure the sensitivity of individual stock to the fluctuations of the overall stock market.

How is the standard deviation of returns for individual common stocks or for a stock portfolio calculated?

A common measurement of the spread of outcomes on different investments is done by measuring the variance or standard deviation of the possible outcomes. The variance is the average of the squared deviations around the average outcome, and the standard deviation is the square root of the variance. The standard deviation of the returns on a market portfolio of common stocks has averaged about 20 percent a year.

Why does diversification reduce risk?

The standard deviation of returns is generally higher on individual stocks than it is on the market. As individual stocks do not move in exact lockstep, most of the risk can be bifurcated away. By spreading your portfolio across many investments you smooth out the risk of your overall position. The risk that can be eliminated through diversification is known as unique risk.